The New Frontier of Managed Accounts A Fund Strategist Portfolios Primer

Transcription

1 The New Frontier of Managed Accounts A Fund Strategist Portfolios Primer Author: Brooks Friederich, Senior Investment Analyst, Envestnet PMC FOR HOME OFFICE AND ADVISOR USE ONLY-NOT FOR USE WITH THE INVESTING PUBLIC

2 A New Frontier of Managed Accounts A series of financial crises over the last dozen years has forced many investors to reassess their investment choices and their tolerance for risk. There are new factors to consider: Financial markets are more globally connected than ever before. Product innovation has become complex, and so have portfolio solutions and asset allocation decisions. Compliance and regulatory mandates for advisors have increased dramatically, leading to a lot of confusing conversations about fine print. So how can advisors meet investors needs, stay on top of emerging best practices and still have time to select great investment products in a rapidly changing, globally connected complex and even chaotic marketplace? One way is to outsource to a new type of investment product that manages both product selection and asset allocation, called a Fund Strategist Portfolio ( FSP ). For those advisors that do not have the time or inclination to do their own asset allocation and manager research, monitor underlying investments and rebalance multiple accounts, FSPs can provide an effective solution which is why they have quickly become an integral component of many financial advisory practices. As advisors seek to cushion the potential volatility of longterm strategic portfolios in an effort to prevent the kind of panic that possessed investors in the wake of the 2008 market meltdown they have sought to expand their toolkit, incorporating more dynamic strategies that adjust portfolio allocations in an effort to protect or even profit from market swings. For instance, advisors are starting to incorporate liquid alternatives, sector rotation, tactical go anywhere managers and other investment styles. Today, with the help of FSPs, advisors can embrace a flexible framework for portfolio construction that incorporates longterm strategic, core-satellite and more tactical investment solutions, using a single FSP, a combination of FSPs or a combination of openarchitecture FSPs that they can populate with their own chosen managers. What is a FSP? Fund Strategist Portfolios ( FSPs ) can provide advisors access to investment strategists who construct distinct portfolio solutions to help meet the ever increasing demands of today s investors. They typically comprise a set of mutual funds and/or exchange-traded funds (ETFs). FSP solutions espouse various approaches to portfolio construction and asset allocation: whereas most FSP portfolios employ a long-term, strategic asset allocation approach, others take a dynamic or tactical approach and actively shift allocations in order to take advantage of short-term market movements. FSP Investment Styles Fund Strategist Portfolio solutions range from traditional long-term, buy-and-hold investment mandates all the way to tactical solutions that utilize quantitative, short-term market-timing investment techniques. FSP solutions can provide investors with a variety of asset classes, investor goals, and risk tolerances. Envestnet PMC categorizes FSPs into four distinct categories: Strategic, Dynamic, Tactical and Satellite. 2 The New Frontier of Managed Accounts

3 Strategic A long-term, buy-and-hold investment approach that attempts to balance capturing broad market returns with an appropriate level of risk. Strategic FSPs tend to be highly diversified across major asset classes and rebalance periodically to their original target allocation. Strategic FSP solutions can serve as the core portion of a client s portfolio or as a total portfolio solution. Options provided in this space span the risk spectrum from conservative to aggressive. Strategic FSP Historical Asset Allocation / /2009 4/ /2010 4/ /2011 4/ /2012 4/2013 Large Cap Equity Mid Cap Equity Small Cap Equity Int'l Developed Equity Emerging Markets Equity Intermediate-Term Fixed Income Long-Term Fixed Income Cash Alternative Source: Envestnet PMC. Representative sample asset allocation of an FSP categorized by Envestnet PMC as Strategic. Dynamic A flexible investment approach that combines a strategic approach with a limited amount of short-term, tactical moves. Dynamic FSPs typically remain fully invested and diversified plus, they attempt to take advantage of short-term macroeconomic and/or market factors to enhance their returns. Like Strategic FSPs, these flexible portfolio solutions may serve as the core portion of a client s portfolio, or as a total portfolio solution. Dynamic FSPs are typically available across the entire risk spectrum. Dynamic FSP Historical Asset Allocation /2010 3/2011 6/2011 9/ /2011 3/2012 6/2012 9/ /2012 3/2013 Large Cap Equity Mid Cap Equity Small Cap Equity Int'l Developed Equity Emerging Markets Equity Intermediate-Term Fixed Income Long-Term Fixed Income Cash Alternative Source: Envestnet PMC. Representative sample asset allocation of an FSP categorized by Envestnet PMC as Dynamic. The New Frontier of Managed Accounts 3

4 Tactical An unconstrained investment approach that can quickly change its allocation and risk profile by moving portfolio allocations from as much as 100% equities to 100% fixed income and cash (and vice versa). Tactical FSPs attempt to actively move in and out of asset classes, sectors or countries based on their forecasts of short-term changes in market environments. Tactical FSP strategies typically employ a combination of technical and quantitative factors, using rules-based methods that may combine macroeconomic analysis and quantitative statistics such as momentum, moving averages, relative value and relative volatility. These strategies are typically utilized as a complement to a client s existing portfolio, with the goal of protecting capital in down markets while participating in up markets. Tactical FSP Historical Asset Allocation /2008 3/2009 9/2009 3/2010 9/2010 3/2011 9/2011 3/2012 9/2012 Equity Fixed Income Cash Other Source: Envestnet PMC. Representative sample asset allocation of an FSP categorized by Envestnet PMC as Tactical. Satellite FSPs In addition to the specific styles of FSPs, there are specialized portfolio solutions that either aim to manage or reshape portfolio risk, or focus on a single asset class. Most of these Satellite FSPs incorporate various elements of strategic, dynamic and tactical investment approaches. They typically serve as a complement to a client s overall portfolio; or, a Satellite FSP may serve as the dedicated portion of the asset class that the FSP attempts to capture through its investment mandate, such as: Long/Short Global Macro Alternative Fixed Income Hedged Equity Multi-Asset Commodities Income/Yield This collection of FSPs has grown rapidly as the demand for unique mandates which may focus on lowering portfolio volatility, reducing downside capture, lowering correlations, enhancing income and yield, or hedging has steadily risen. With the continued evolution of the ETF universe, FSP strategists have a growing number of levers and pulleys to choose from as they attempt to capture specific market trends. 4 The New Frontier of Managed Accounts

5 Growth of FSPs It is no surprise that the growth in the number of FSPs, and their assets under management, have coincided with the rise in demand for ETFs the vehicle used by many third party strategists. ETFs have transformed the way investors can access various asset classes around the world, including, in addition to equities and domestic bonds, commodities, foreign equities, and non-u.s. bonds. As of the end of 2012, BlackRock counted a universe of more than 100 ETF-only managers offering 225-plus strategies which represented $54 billion in assets. Those figures are up from 95 strategists offering 206 portfolios and $38 billion at the end of Morningstar estimates the market to be even bigger (which includes strategies using mutual funds), with $63 billion in assets across 530 strategies from 125 firms as of December 2012 (ETF Managed Portfolios Landscape Report). The amount of assets in FSPs on the Envestnet platform has experienced this same rapid growth, as seen below. Empowered by the rapid evolution of ETFs, FSPs are changing the way advisors invest, allowing their clients both big and small to gain access to institutionalcaliber portfolios that are designed to provide lower costs, better transparency and greater tax efficiency than ever before. All FSP Assets December 31, 2012 $30 $25.8 Billion $20 BILLION $15.0 Billion $10 $0 JAN 2011 MAR 2011 JUN 2011 SEP 2011 DEC 2011 MAR 2012 JUN 2012 SEP 2012 DEC 2012 Source: Envestnet Inc. The New Frontier of Managed Accounts 5

6 Attributes Resonating with Advisors A majority of advisors today are spending more time conducting manager research and asset allocation work, monitoring underlying investments, and rebalancing client accounts than they do servicing existing relationships and recruiting new investors. FSPs ease of use provides benefits both to the advisor and to the end investor. The Strategists provide an effective way for advisors to access institutional caliber asset allocation and manager selection expertise while freeing time to communicate with existing clients and concentrate on growing their business. One of the advantages of FSP strategies is that advisors do not have to have an explicit view on the markets but can rely on the expertise of the third-party strategist to make those difficult asset allocation and manager selection decisions. This provides a more objective approach to managing client assets and, again, allows advisors more time to service their existing relationships and build new ones. Top Decision Drivers for Outsourcing Access to asset allocation models Advisor access to managers they could not access on their own The potential to generate alpha through best investment ideas Portfolio construction Portfolio monitoring Access to managed account expertise Access to alternative investments expertise Superior back-office technology and support Access to unified managed account (UMA) capability Overlay management Outsourced Investment Management Activities According to a recent survey conducted by Northern Trust nearly 50% of polled advisors outsourced all investment management activities, while 6 out of 10 advisors outsourced more than half of their clients assets. 15% 15% 20% 50% n All investment management activities n All investment management-related back office operations n Just specific asset classes n Just specific investment management-related back-office operations Source: Investment Management Outsourcing: The State of the Art 2012, Northern Trust The New Frontier of Managed Accounts

7 Time: A vast majority of advisors time is spent on investment related tasks. Time Spent on Investment Management Related Tasks Could Consume the Equivalent of Two Workdays Per Week for >40% of Advisors Amount of Time Advisors Spend Doing Investment Manager Research Portfolio Construction Portfolio Monitoring > 5 Hours 40% 42% 58% > 5 Hours > 5 Hours 39% 40% 57% 2 5 Hours 21% 26% 23% 2 5 Hours 2 5 Hours 21% 27% 27% 1 2 Hours 15% 20% 12% 1 2 Hours 1 2 Hours 13% 24% 13% <1 Hours 24% 12% 7% <1 Hours <1 Hours 26% 9% 2% n All Advisors n Larger Firms Source: Investment Management Outsourcing: The State of the Art 2012, Northern Trust Cost At a time when many asset classes proffer low average returns, cost becomes an important factor in clients ability to grow their assets. As a result, advisors and their clients are demanding lower-cost investment options, without sacrificing access to sophisticated solutions. Most FSPs provide a total portfolio solution at a very competitive cost. According to the Northern Trust survey, nearly 60% of the advisors who outsourced to third party strategists reported no change in fees charged to clients, while 15% reported that fees had decreased. And the typical minimum account size for many FSPs is $50,000 or below, making these portfolio strategies accessible for clients of all sizes. Transparency Faced with ever-increasing rules and regulations and investor demands, as well as constant changes in investments and technology, advisors and their clients now have more have more need (and ability) to know what they own. Since most FSP strategies use liquid ETF and mutual fund vehicles to create their solutions, advisors and clients have daily insights into their underlying positions, and how those positions might be affected by developments in the global financial markets. Liquidity Today, liquidity is a major concern for both advisors and investors. In our opinion, most clients do not want their wealth locked up in an investment that cannot provide them with access to their funds within a short period of time. Liquidity is comforting -- and the uncertainty associated with illiquid investments can be stressful for both investors and advisors. Liquidity is one of the key operational benefits of FSP solutions. The New Frontier of Managed Accounts 7

8 Access to Various Investment Styles, Philosophies and Portfolio Construction Methods An advisor looking for a strategist portfolio solution will be able to find one to suit practically any need, and practically any investment style. FSP solutions can range from the plain-vanilla to complex, tactical solutions featuring a pinpointed asset class. Each FSP has its own take on the markets and associated risks. This enables an advisor to pick the strategist whose views on the general markets, risk and portfolio construction align with his or her own practice and the client s needs. FSP solutions provide unique solutions across the traditional asset classes, specific countries or regions, different sectors (domestic and non-u.s.), alternatives, commodities, or specific risk profiles. Some FSPs serve as the core of a client s total portfolio while others can act as a diversifying complement to an existing core allocation. Stay Invested - Stay Diversified When portfolio construction, manager selection and portfolio rebalancing responsibilities are outsourced to a third-party strategist, advisors and their clients are at arm s length from the daily investment decisions. This can help avoid ill-timed decisions based on emotions. Historically, investors who attempt to move in and out of the market typically erode alpha and trail behind traditional buy and hold strategies. And, as the chart below suggests, investors have typically done a poor job at attempting to time the market. S&P 500 Performance of a $10,000 Investment vs. Industry Equity & Bond Fund Flows January 1990 February 2013 S&P 500 $75,000 Equity & Bond Fund Flows ($ Bn) Buying High $50.0 $50,000 $25.0 $25,000 $10,000 Investment $0.0 $0 -$25,000 -$25.0 -$50,000 Equity Fund Flows Bond Fund Flows S&P 500 Performance Selling Low -$50.0 JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN Source: Strategas & S&P 500; Adapted from Franklin Templeton Time to Take Stock Brochure 8 The New Frontier of Managed Accounts

9 A New Frontier of Research and Due Diligence FSPs range from simple to sophisticated; however, only limited research is available on most of these firms and their underlying strategies. The multiple, sometimes complex dimensions of FSP strategies require in-depth research and due diligence in the areas of asset allocation, investment vehicle usage, strategy flexibility, risk controls, investment time horizon and many other areas. The continued growth of unique FSP offerings, along with product innovation within ETF and mutual fund strategies, warrants a high level of research and due diligence when selecting FSPs for clients. Given their broad and flexible investment mandates, FSP strategies are all quite different from one another. Both investor education and research and due diligence on these popular products remains a near-term hurdle. We would encourage advisors to thoroughly review the multiple areas of potential risks at both the firm and underlying strategy level. Traditional manager research and due diligence can be effective in selecting and monitoring FSP strategies. However, additional elements outside the customary quantitative and qualitative metrics need to be used to better evaluate many FSP strategies. Focusing initial research and due diligence efforts at the firm level is a critical component. Many FSP firms are relatively small and some have a history that is more like a traditional RIA than an asset management firm. Focusing on the firm s holistic approach to money management is an essential part of the research and due diligence process on FSP Elements Worth Evaluating Qualitative Firm Investment Team Investment Philosophy & Process Investment Type & Style Investment Mandate & Portfolio Fit Quantitative Models / Signals Product Lineup Quantitative Track Record actual or hypothetical Minimum/Maximum Asset Class Exposures Risk Profile & Risk Controls Benchmark Performance Evaluation Peer Group Performance Evaluation Underlying Investment Vehicles Used Trading A Broader View of FSP Style Considerations Market Cap Large Medium Small Equity Value Core Growth Investment Style Quality High Medium Low Fixed Income Short Int. Long Duration Vehicles Used Individual Stocks/Bonds ETFs Mutual Funds Strategy Type Strategic Traditional MF & SMA Portfolios Dynamic X X X Tactical X X X X X The New Frontier of Managed Accounts 9

10 FSP firms and their respective strategies. Most, if not all, FSP managers have distinct investment philosophies and views on the markets, follow different approaches in constructing their portfolios, and utilize varied investment vehicles to implement their views and portfolio construction. Additionally, each firm typically has its own view of risk, whether it is risk as measured by volatility of the global equity markets or the risk of losing money. Some managers attempt to reduce risk, or volatility, while others purposefully increase risk with the goal of increasing return. Finally, benchmarking or peer group comparisons can be a challenge, especially when the strategies have flexible investment mandates and variable market exposures. For these strategies, it s important to understand which securities the strategist qualifies as cash or out of the market. When tactically rotating out of asset classes, it s important to understand placement of those assets and the maximum defensive allocation. Some strategies hold U.S. Treasury ETFs or high-quality fixed income mutual funds, while others prefer short duration credit vehicles or a simple money market fund. Some strategies employ a tactical fixed-income model to manage the non-equity portion of the portfolio, which can have additional implications on a strategy s total risk profile. 10 FSPs An Effective Answer to the Complexities of Investing FSP strategies provide a simple and effective investment solution for advisors who lack the time or resources to do extensive manager research and asset allocation work, monitor underlying investments, and rebalance multiple accounts. From among the various types of investment styles, philosophies, methodologies, and investment vehicles used to implement these portfolio solutions, most advisors will find solutions that suit the needs of any investor. In a universe that encompasses a wide variety of unique investment mandates, the Envestnet FSP network offers clients choice and guidance for its clients. Our network offers more than 65 thirdparty firms and more than 700 unique investment strategies. Envestnet s FSP network empowers advisors to help develop a sound, long-term asset allocation and build portfolios designed to keep their clients disciplined through varying market cycles. Whether you seek a long-term, strategic diversified portfolio or a manager with a nearterm tactical viewpoint, Envestnet s FSP network provides access to high-caliber investment strategists who lead the industry. The New Frontier of Managed Accounts

11 Author s disclaimer Past performance is not indicative of future results. The opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Investment decisions should always be made based on the investor s specific financial needs and objectives, goals, time horizon, and risk tolerance. Information obtained from third party resources are believed to be reliable but not guaranteed. Any mention of a specific security is for illustrative purposes only and is not intended as a recommendation or advice regarding the specific security mentioned. Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses. Derivatives may be riskier than other types of investments because they may be more sensitive to changes in economic or market conditions than other types of investments and could result in losses that significantly exceed the original investment. The use of derivatives may not be successful, resulting in investment losses, and the cost of such strategies may reduce investment returns. About Envestnet Envestnet, Inc. (NYSE: ENV) is a leading provider of unified wealth management technology and services to investment advisors. Our open-architecture platforms unify and fortify the wealth management process, delivering unparalleled flexibility, accuracy, performance and value. Envestnet solutions enable the transformation of wealth management into a transparent, objective, independent and fully-aligned standard of care, and empower advisors to deliver better results. Envestnet s Advisor Suite software empowers financial advisors to better manage client outcomes and strengthen their practice. Envestnet provides institutional-quality research and advanced portfolio solutions through our Portfolio Management Consultants group, Envestnet PMC. Envestnet Tamarac provides leading rebalancing, reporting and practice management software. For more information on Envestnet, please visit The New Frontier of Managed Accounts 11

12 The information, analysis, guidance and opinions expressed herein are for general and educational purposes only and are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Envestnet makes no representation regarding the accuracy or completeness of the information provided. Information obtained from third party resources are believed to be reliable but not guaranteed. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Past performance is not indicative of future results. FOR HOME OFFICE AND ADVISOR USE ONLY-NOT FOR USE WITH THE INVESTING PUBLIC 2013 Envestnet. All rights reserved. PMC-WP-FSP-1013